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IMF Concludes Article IV Consultation With Cyprus

by Lorys Charalambous,, Cyprus

23 February 2007

The Executive Board of the International Monetary Fund (IMF) on Wednesday released the conclusions of its Article IV consultation with Cyprus.

The report stated that:

"Executive Directors welcomed the Cypriot authorities' substantial progress in addressing macroeconomic imbalances and reforming the economy. Inflation has receded, the fiscal deficit was cut sharply, and the economy has continued to recover, raising living standards in Cyprus closer to those in the rest of the EU and placing the economy at the doorstep of the EMU."

"Directors noted that continued observance of the Maastricht criteria, in particular the inflation criterion, and a smooth adoption of the euro will lay the groundwork for sustained growth going forward. This will require both fiscal and wage restraint, along with policies fostering domestic competition and continued vigilance of monetary policy."

"Directors welcomed the favorable fiscal outturn in 2006 and the focus on durable fiscal measures in the 2007 budget. They encouraged the authorities to remain ambitious in their fiscal adjustment efforts to safeguard against inflation risks by observing spending limits, avoiding supplementary budgets and saving any higher-than-envisaged revenues."

"Directors supported the authorities' intention to balance the budget by 2010 and stressed that high-quality fiscal adjustment should be ensured by keeping current expenditure in check. They welcomed the planned full implementation of a medium-term budget framework in 2008, as it would provide a strong institutional framework to rationalize, prioritize, and control public expenditure. Directors considered the suspension of the ambitious public investment program to be appropriate to allow the authorities to put in place a proper legal framework and institutional setting for private-public-partnerships. These actions will help bring economic considerations to bear on the selection and procurement of public investment projects."

"Directors stressed that long-run fiscal sustainability hinges on mitigating the aging-related pressures on public expenditure. They called on the authorities to implement pension reforms that would allow the social security system to deal with adverse demographic trends, noting that prompt action would allow a more gradual phasing in of reforms and grandfathering of the rights of employees. Directors noted the need to avert rising health care costs when the National Health Insurance System is introduced in 2008 and encouraged the authorities to consider adequate incentives to this end, such as user fees."

The assessment continued:

"Turning to the financial sector, Directors noted that commercial banks are profitable and well capitalized. Nonetheless, non-performing loans, while declining, remain high. Rapid credit growth and brisk house price increases could become sources of risk, and the authorities should stand ready to take appropriate measures if the pace of credit growth does not abate and risks increase."

"Directors welcomed improvements in financial sector supervision, while encouraging steps to consolidate the supervision of commercial banks and cooperative credit institutions. Irrespective of the institutional framework, supervisors should have clear responsibilities and objectives, operational independence, professional staff, and adequate resources. Directors encouraged the early adoption of legislation and regulations to accelerate the lengthy foreclosure process and welcomed the authorities' intention of completing an Financial Sector Assessment Program in time for the next Article IV consultation."

"Directors stressed the importance of safeguarding external competitiveness to sustain economic growth. While recognizing that the current wage-setting process has helped smoothen labor relations, Directors concurred that continued high real wage increases point to the need to move towards a mechanism that would better align real wage increases with productivity developments. Directors welcomed progress in opening the telecommunications and energy sectors, and saw scope for further progress to enhance competition in these markets."

And concluded:

"Directors encouraged continued efforts towards reaching an agreement on a framework under which Fund technical assistance could be provided to the Turkish Cypriot community in the non-government-controlled areas of the Republic of Cyprus. In this respect, several Directors welcomed the pragmatic approach adopted by the Cypriot authorities."

"Directors welcomed the authorities' intention to subscribe to the Special Data Dissemination Standard by 2008."

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